Stocks in the healthcare sector have lagged behind the market for months, but that may soon change, according to Andrew Acker, portfolio manager at Janus Henderson Investors.

Circumstances are converging to bring a boost to the sector, Acker said in an interview.

Healthcare stocks fell out of favor for 2022 and that has continued so far in 2023, Acker acknowledged. “Firms that helped engineer the world out of the pandemic and received a boost in sales are now experiencing a downturn," he said. "There is a post pandemic hangover.”

In addition, talk of a soft economic landing, rather than a recession, actually works against the perceived value of defensive stocks such as healthcare shares.

“There’s now more of an expectation that we’re going to have a soft landing. We’ve seen inflation coming down. But we think those risks [of a recession] still remain. We also have to keep in mind that all of the monetary slowing that’s been in the pipeline still takes time to play out,” the portfolio manager said. “So, we think as that works its way through the economy, we could still see a substantial slowing of the economy and a potential recession, especially as we get into 2024.”

“If there is no recession, investors will be less interested in defensive stocks like healthcare that preserve capital but limit gains. But if there is a significant slowing of the economy, that’s when I think the defensive characteristics of the healthcare sector really rise to the fore and become more appreciated,” Acker said.

An inverted yield curve, in which short-term bonds pay a higher rate than long-term bonds, which the U.S. is now experiencing, usually leads to a slowing economy, Acker noted. The slowing growth of the rest of the economy makes healthcare a good bet for investors. At the same time, the underlying fundamentals for healthcare are strong, he added.

Innovation also is accelerating and could drive mergers and acquisitions in the near term and be the basis for growth for years to come in the healthcare sector, he said.

Daniel Lyons, portfolio manager and research analyst, at Janus Henderson Investors, said during a recent video presentation with Acker, “We’re seeing that large pharma has a huge need to fill their pipelines, and they’re going shopping and buying companies that are truly innovative in this space.

“We think that there’ll be even more of that to come,” Lyons said. “I’ve seen estimates of around $600 billion of cash that’s out there available for potential spending on M&As. And we think that’s going to be an important driver of (investment) interest in the sector.”

The innovations in healthcare also are fueling a comeback for the sector, Acker said.

“The level of innovation has never been higher,” he said. “This could be a record year for new medical products and procedures to treat cancer and other diseases. One of the companies we have in our portfolio is an innovative, targeted gene therapy to treat cancer.

“This year we think will be a record year for new products; as many as 80 could be coming to the market. And this is driving a whole new product cycle in healthcare that we think could drive growth, not just for the next few years, but for the next decade or more,” Acker said.

Because healthcare stocks have not been popular recently, stocks in the sector are trading at an attractive discount, he said. “With healthcare priced below the market average, attractive valuations could boost the sector’s long-term return potential,” he added.

Although healthcare has lagged the equity market so far in 2023, the sector’s long-term outlook appears stronger than ever, Acker and Lyons agreed.

It is human nature to become less interested in a stock after a period of underperformance, but that is “exactly when we think an investor should be more interested,” Acker said. “We see a combination of an attractive entry point, the potential for a slowing economy, and high innovation in the sector, all driving a very attractive time to be looking at the sector.”